The U.S. Supreme Court ruled on Monday that an underwater second mortgage cannot be extinguished, or “stripped off,” as unsecured debt for a debtor in bankruptcy, according to the Supreme Court’s website.

In the cases of Bank of America v. Caulket and Bank of America v. Toledo-Cardona, Florida homeowners David Caulkett and Edelmiro Toldeo-Cardona had filed for Chapter 7 bankruptcy and had second mortgages with Bank of America extinguished by a bankruptcy judge following the housing crisis of 2008 based on the fact that they were completely underwater. On Monday, just more than two months after hearing arguments for the case, the Supreme Court ruled in favor of the bank.
When the Supreme Court heard arguments for two cases on March 24, attorneys representing Bank of America contended that the high court should uphold a 1992 decision in the case of Dewsnup v. Timm, which barred debtors in Chapter 7 bankruptcy from “stripping off” an underwater second mortgage down to its market value, thus voiding the junior lien holder’s claim against the debtor. Attorneys for the debtors argued that the Dewsnup decision was irrelevant for the two cases.
Bank of America appealed the bankruptcy judge’s ruling for the two cases, but the 11th Circuit U.S. Court of Appeals upheld the bankruptcy court’s decision in May 2014, going against the Dewsnup ruling by saying that decision did not apply when the collateral on a junior lien (second mortgage) did not have sufficient enough value. The bank subsequently appealed the 11th Circuit Court’s ruling.
The Supreme Court ruled on Monday that the second mortgages should not be treated as unsecured debt, hence upholding the Dewsnup decision. Justice Clarence Thomas, in delivering the opinion of the court, wrote that, “Section 506(d) of the Bankruptcy Code allows a debtor to void a lien on his property ‘[t]o the extent that [the] lien secures a claim against the debtor that is not an allowed secured claim.’ 11 U. S. C. §506(d). These consolidated cases present the question whether a debtor in a Chapter 7 bankruptcy proceeding may void a junior mortgage under §506(d) when the debt owed on a senior mortgage exceeds the present value of the property. We hold that a debtor may not, and we therefore reverse the judgments of the Court of Appeals.”
“The Court has spoken, and we respect its ruling,” said Stephanos Bibas, an attorney for defendant David Caulkett, in an email to DS News. “But we are disappointed that the Court extended its earlier precedent in Dewsnup v Timm, even though it acknowledged that the plain words of the statute favor giving relief to homeowners such as Messrs. Caulkett and Toledo-Cardona. We hope that in the near future, the Administration’s home-mortgage-modification programs will offer more relief to homeowners in this situation struggling to save their homes.”
A Bank of America spokesman declined to comment on Monday’s Supreme Court’s ruling

In a former Newsletter, I (J.ROBERT ECKLEY) noted the increasing turn to seller-carried finance in residential, commercial & business sales. I predicted that the use of it would solidly increase as conventional lending became ever more deleveraged, inflexible, complex and adverse as sellers (now getting a 1/4 point on their savings accounts) saw the benefit of collecting comparatively generous interest on seller-carries (now running between 6% and 8%, many even higher). That prediction has certainly proven to be accurate.

Seller-carries are now a significant part of most markets and they are growing monthly, everywhere. By way of a growth example, for residential sales, in 2009, the various MLS systems and private escrow reports (a lot of seller-carries are not reported in MLS for various reasons) in the southwestern U.S. reported a seller-carry median average percentage of the reported “sold” of less than 0.5%; markets “sold” on seller-carries in the same areas are this year reported as just under 15% of the marketplace and growing. San Diego, which closed 0.5% of the reported sales on seller-carries in 2009, went to 2.3% in late December, 2010 and was at 12% in mid-2015. Phoenix went from almost zero in 2009 to a little under a current 17%. Seller-carried commercial sales (sale-buybacks, sale-leasebacks, lease/options, stock or equity swaps, 1031 exchanges and other creative transactions involving no or little conventional finance) are running 22% of all “sold” in the same areas. Sales of business opportunities using seller-carries are between 65% and 70% and seller-carries compose almost 80% for bare land and private sale farms and ranches. This is still below the historical levels of residential and residential development sales during the last downturn (1982-1988) which ranged closer to a third of all deals across the board. What this translates into is millions and millions of dollars of deals done and commissions paid that otherwise could not or would not necessarily have happened under conventional lending and deal models! That’s not chump change any time, let alone in these ruptured times.

But there is a problem. The transactional community-all of the way from the real estate broker, to the mortgage brokers, to escrow closers and title insurers-is not ready for this seller-carry onslaught, either practically or legally. Not only are there few basic real estate licensure schools that still even teach seller-carries to future brokers (they did away with those classes as “obsolete” when the country went through that period when conventional lenders would finance anyone buying anything at any price) but there are also few escrow officers left who are old enough to have learned how to set up and close them, in the 80’s, when seller finance was SOP in the industry. They retired.

Yet the problem is even greater than lack of understanding and experience. It’s the legal side – the Dodd-Frank Act, the SAFE Act, the Home Owners Equity Protection Act and the myriad of complex rules of the Consumer Financial Protection Bureau – with standards that all must be met to the letter, which confounds the job of lawfully creating and closing the seller-financed consumer/residential sales transaction, as 80% of the daily real estate sales market tends to be. All of those laws and rules now also apply to seller finance for the average residential property being purchased by an owner-occupier and some of these standards and legal requirements, if violated, can mete out not just licensure loss and liability to clients, not just stiff public fines and publishing in the CFPB’s national online “Hall of Shame,” but even some serious jail time. In the 80’s, these rules and the harsh penalties – all 24,000 pages of them to date – did not exist. With these rules, it just got more complex to write lawful seller-carries. It did not, by a far cry, make them non-viable, unpopular, or obsolete, as the doubling and tripling of their use in today’s market by those “in the know” more than can attest.

Is stiffer regulation the progressive end, though, of the explosively growing seller-carry market? Nope. But it is the end of any patience for ignorance about how to do seller financing under the new rules – and the current legal ignorance, if not obstinance – is shockingly rife and across the board. A lot of horror stories about what it cost some poor broker or title company for doing it wrong under the new rules, above, can be told, but this does not teach anything that is constructive (other than not to “mess with the Feds,” but does anyone really need to reminded of that eternal principle?) And it chases away a lot of good deals and good marketing people that could, with the right information and a hook-up with the right compliance support services, put people in properties, raise the market and allow many more attorneys, brokers and escrow officers to become “seller-finance masters” to the immense profit of themselves, their brokerages and firms, their clients and customers in this new marketplace. Ignorance has never been bliss. It is usually just a poverty-paved road to fatality.

To identify one resource for mastering the seller-carry market, some terrific classes on the “how-tos” of seller-finance are now developed and out there. Old seller-finance lawyers, like the author of this article, have been brought back to the forefronts they once enjoyed before they were unseated when the Banks lost their minds (and forgot a novel concept called “safe and sound banking practices”) for that decade or so until the Feds intervened with these new rules. When lenders were willing to shovel trillions of dollars into the Black Hole of Underwriting Abstinence, any competition from seller-carries was derailed and with it those who taught it. All of those great transactional techniques and forms developed from the experiences of those millions of seller-carry transactions done across the U.S. in the 80’s went to a dusty closet, until now. Those instructors and their magnificent forms are back in full force… and, well…finally out of the closet, so to speak! (P.S. One serious criterion to use in selecting which instructors, lead brokers, lawyers, escrow officers or other mentors to learn from or which can provide a capable support service is to seek those people out in your line of business who were there and did them in the 80’s-don’t just look for anyone old enough to have done them, but find those who were in the trenches making steady money marketing, writing and closing seller-carries. In an era which almost religiously worships youth, it is risky to say this but the fact is: Find and ally with the “Gray Hairs” in this transactional area and The Force will almost always be with you! It really is an art that starts with focusing the mind well before sharpening the pencil.

The professionals for the “Seller-Carry Team” need to be carefully selected for their competence and their complete compliance with the rules. Note the point that they must be “rule compliant.” That is entirely different than those holding themselves out as having a “system” or “technique” to AVOID the rules. That’s the Devil whispering. There are no “secret back doors” or “shortcuts for insiders” to by-pass these dense and very well-written rules. At least none that do not involve handcuffs at some point. The contentions that there are some “tricks” and “loopholes” came from a range of ignoramuses, charlatans and outright crooks. And compliance is not that hard or expensive when compared with the alternative of checking into Sing Sing. Here is the usual cast of professional players in a typical seller-carry now and what they can and cannot do:

One needs a lawyer who knows seller-carry dynamics AND those new consumer and licensure rules above to draft the core transactional documents. Not necessarily to draft the initial purchase commitment which the real estate broker typically first drafts to get the parties initially together (though it is smart to have a lawyer help even with that for the few couple of times to assure the initial deal is stated right so as to avoid the unsettling and embarrassing need to change a “done deal” later because it crashed into an adverse rule). The lawyer should ALWAYS draft the final core financing documents that come thereafter at closing. And that lawyer should be specifically working as the direct attorney for at least one the parties, typically the seller in seller-carries (where seller is in that scenario “the Bank” and has a solid right to fashion the paperwork on which his money will be lent). That attorney should not also do work for the same brokerage or for the title or escrow company who profits only from a closing-that is a clear conflict of interest. The same attorney should not work for a mortgage broker (though they can help with SAFE Act questions, truth-in-lending and other loan disclosure documents when the deal requires). And, good grief, they should be a REAL attorney and not “that guy at the front desk at the dry cleaners who did these once before in the 80s before he lost his license and went into bankruptcy. And the transactional documents should definitely not come from forms (probably drafted by that same guy at the dry cleaners or someone like him) found on the internet!

Next, a licensed Mortgage Loan Originator (“MLO”) will likely be required both as a matter of offloading the high-risk position of evaluating the borrower’s current credit and likely future loan performance, but also to comply with the new consumer protection laws which in some cases make use of the MLO mandatory in seller-carries. MLOs are the professionals now officially mandated by the SAFE Act to determine the creditworthiness of the buyer for the benefit of the seller’s final decision to make the loan represented by a seller-carry. The CFPB and drafters of the federal SAFE Act rightly believe that the seller needs professional-level underwriting input to competently make the decision to grant or deny a loan to the buyer and the buyer needs protection against rip-off, predatory loan terms (usually unlawful under HOEPA). Real estate brokers and escrow officers or attorneys for them are NOT authorized to act as MLOs nor are they permitted to make the same credit evaluations or engage in the same underwriting acts without an actual MLO license. MLOs take the buyer’s credit application, do balance and employment verifications, run FICOs, tri-merges, apply credit models and finally rate the buyer for the benefit of the seller. Yes, there are some deals where an MLO is not required by the SAFE Act to meet the seller-carry law, such as non-consumer transactions or consumer transactions involving a single seller-financed sale in any 12 month period (backward in time and forward in time) or sales of bare land with no residential building intentions but even for the exempt deals, is there EVER a time when an honest, knowledgeable, bright lawyer, real estate broker, title or escrow company wants to take the liability of certifying to the seller the buyers creditworthiness for years to come and without having a license for that and also doing so without having done any of the standard loan due diligence underwriters do? Want to be a free guarantor for the buyer’s perfect performance for years into the future? One word on that: Dumb. And if that single word did not make the point well enough, here’s another few to balance it out: Welcome to your Chapter 7. Obviously, this does not even cover the point that it is a severe conflict of interest for any of these professionals to both advise the seller that the buyer has the financial horsepower to do the deal AND make money from that deal only because the seller took that advice and did not cancel the deal when-in retrospect some day when it blows up–he should have.

Now to the title and escrow companies. Do not avoid the use of title insurance, closing and collection escrows, even in seller-carries and especially because it is a seller-carry. Seller-carries need the same closing and collection mechanisms as conventionals. They need a competent closer to get prorates and recordation properly done. They need title insurance to assure seller’s title status and an account servicer to be set up to count the beans correctly and assure that the interest paid and interest received statements that are given to IRS by each party each year actually match. They can and should hold final transactional fulfillment conveyance or lien release instruments for buyers’ safety and they can hold and pay reserves where needed. They are essential to a well-conducted deal. But lately, maybe because these vendors are hungry in this tight economy, some are running amok across all of the above consumer rules, exposing themselves and all of the other professionals, let alone the other transactional parties, to atrocious and devastating liabilities. More on that.

Some very misinformed title companies, escrows and agencies are drafting the preliminary and even the final seller-carry transactional documents putting the deal together and apparently “approving” the buyer to the seller and closing the loan without any participation of outside counsel at least for the seller, any lawyer at all in some cases, and all without a licensed MLO. Worse, these rogue entities are even contending that they CAN lawfully do that. That’s the Devil’s whispering, again. They CANNOT do those things or play those roles without engaging in the unauthorized practice of law (see ** below after this article), without, even if they do have their own lawyer, a very serious conflict of interest, without engaging in unlicensed real estate brokerage and unlicensed MLO activity, all violating the SAFE Act and the CFPB and their own and other licensure rules. These wrongful acts seed the transaction with huge state and federal defects that have unbearable, non-dischargeable penalties (up to $1 million a day for all concerned which penetrates any entity to reach the principles). Moreover, the above consumer protection rules may require a number of technical and complex side-paperwork, phrases and broker disclosures to be in the transactional forms and the author of this article has yet to see a single form from title and escrow entities or their attorneys that comply with those. Who ran the APOR for the HOEPA interest test? Who underwrote the ATR and what convention was used? Where are the written SAFE Act seller and buyer personal exemption-statuses or exempt collateral verifications? Who determined that the buying or selling entity qualifies under the SAFE Act under the “Ladder Doctrine” (a rule in which a series of transactions which are substantively allied by a common entity or person inside the entity are all counted towards determining a SAFE Act transactional number or exemption)? The answer observed from most all of the escrow forms out there when asked these questions is:.. Huh?

As noted, above, the transaction may be one in which the use of an MLO is mandatory under the federal SAFE Act and companion state laws and these title and escrow entities are NOT MLO’s nor should they close anything unless they have an outside attorneys’ transactional documents in place, or an outside MLO’s Underwriting Certificate indicating that status or that it is non-exempt and the MLO has found the buyer to have the requisite ATR and “passed’ the deal OR that the deal is not subject to mandatory MLO review and may go forward without an ATR finding. Doing or purporting to do what ONLY a licensed MLO can do-just setting up and closing the deal without any of the rest, is courting disaster for all concerned and in some cases a crime by the perpetrator. And is generates a hell of a lot of civil liability, as it makes the loan defective and, for instance, then gives the buyer a right to rescind, demand all of his money back and WALK on the transaction for up to 2 years after closing! That has the added enjoyment of then getting ALL of the participating professionals-all of whom “should have known better”-sued as “aiders and abettors”, regardless of knowledge or intent! “Thank you for using Acme Title & Escrow, where causing the indictment and collapse of ourselves and all our trade partners by flagrant disregard of consumer protection laws is our motto!” This is surely not what title and escrow management wants to see in the company promo brochures or on CNN. And their trade partners – to whom they have been hard-selling “integrity and capability” – sure as heck don’t want to, either. There are a lot of Captain Ahabs out there. Stay off their ships.

THE CONCLUSION: Above all, do learn and use seller-carry finance! It can be the silver bullet that conquers a local market made flat by out-of-reach conventional finance, low appraisals and the bags of bad credit inherited by potential buyers from the financial calamities of the last decade. Just don’t do seller-carries on your own or at least not the first 10 or so. Use the existing education resources, classes and network of professionals to help you stay right, safe, legal and on-track to double or triple your income by learning the seller-financing art. Associate as your trade partners in this some good attorneys, several MLOs with SAFE Act experience, and title and escrow companies that will gladly stick to the business they are licensed to do which is to assure all mandatory documentation is assembled, to close and to collect on deals put together by preceding professionals. Look in all of this lineup for those who have truly “been there and done that”-those gray-haired ones mentioned who can help you do a truckload of lawful, no-hassle deals which leave your less-enlightened competition far, far behind.

‘Nuff said. From the J. Robert Eckley Newsletter

J. Robert Eckley, Real Estate & Banking Attorney

** See for examples of Bar’s opinion on non-lawyers like brokers and escrow officers drafting unique legal documents: Arizona, see Rules of the Supreme Court of Arizona, Sec. V., Regulation of the Practice of Law, Rule 31 A. (1) which provides in pertinent part that the act of “…preparing any document in any medium intended to affect or secure any rights of a specific person or entity..” is the practice of law needing a valid state license for law practice by the drafter. California: In California see the long-followed, definitive People v. Sipper, 61 Cal. App 2d Supp 844 (1943) [and a long list of consistent cases thereafter] in which the Court held that “law practice” needing licensure included “…legal advice and counsel and the preparation of legal instruments and contracts by which legal rights are secured…”

The Consumer Financial Protection Bureau this week issued final changes to its mortgage rules, enabling responsible lending by small creditors, especially those operating in rural and underserved areas.

The new language – proposed in January – aims to increase the number of financial institutions, such as community banks and credit unions, able to offer certain types of mortgages in rural and underserved areas. It also gives small creditors time to adjust their business practices to comply with the rules.

Among the industry-supported provisions is a revised small-creditor definition. The final rule expands the designation to include banks that make fewer than 2,000 loans annually. Previously, the cutoff was 500. Loans held in portfolio – in which community banks retain 100 percent of the credit risk and a direct stake in the loan’s performance – will not count toward the loan total.

Also, industry supporters believe the changes will enable more community banks operating in rural areas to meet the unique mortgage needs of homeowners by deeming portfolio balloon mortgage loans they make to be qualified mortgages under the CFPB’s ability-to-repay rule.

When investing in private mortgage loans, you should rely on someone experienced in reviewing and analyzing these types of alternative investments. It is not rocket science and not a new idea going back to the 1930’s’s with insurance companies. There are a few items to keep in mind as you consider investing in private mortgage loans:

Collateral

We all enjoy purchasing items for a lower cost than average, especially big ticket items right? With a private mortgage loan investment, it is no different. If you lend 50% of the value of an investment property – with the intention of collecting a passive fixed income from the mortgage interest – even if the borrower were to default on the loan, you have inadvertently acquired the real estate asset half off through claiming the real estate title via foreclosure. Depending upon the property, you may be able to rent out the unit and potentially gain a 50%-100% higher annual return than what you were making on passive mortgage interest income. If of course, you wanted to recoup your principal invested and additional profit you could simply resell the property.

Repayment Ability

While how much equity or collateral the real estate contains most often comes to mind when discussing private mortgage loans, the repayment ability of the borrower is a crucial part of determining whether or not to make an investment. The issue of repayment ability addresses the level of certainty as to whether or not a borrower will make the regularly scheduled payments versus defaulting on the loan. If the rental income more than covers the mortgage payment and monthly property expenses, then there’s a higher likelihood of repayment. For a borrower purchasing and renovating a property to resell, if they’ve recently completed and resold previous projects similar to the subject property, then the new loan is being secured should present a higher likelihood of repayment. Requiring the borrower have a certain amount of their own cash into the property also lowers the default risk. Ultimately, most investors desire a passive fixed income investment and generally have an aversion to foreclosing on any property.

Exit Strategy (Loan Repayment)

In this day and age where banks aren’t even lending to well qualified buyers, knowing how your principal investment will be returned is crucial. For example, if you provide a two year interest only balloon loan on a rental property with the strategy for the borrower to refinance or resell, a few factors should be considered. What’s the borrower current credit history? Are there additional free and clear properties or other assets that could repay your loan via selling those assets? Do they have a history of repaying short term loans on other properties that can evidence they’d pay this new one off? What if the real estate market declines and they can’t obtain the resale price they want for the property?

No single answer to the questions listed above will provide a concrete or definitive conclusion, however, the overall experience level of the borrower should be weighed more heavily upon for balloon payments. Each private mortgage investor should be thoroughly aware of how the borrower is going to pay back the loan when it comes due. There are numerous examples of private lenders being forced to extend loan terms on ballooning loans because there’s no way to refinance the property. This can be problematic, especially if the mortgage holder needs to receive their principal investment back at a specific time or deadline. One way to overcome the obstacles present with a balloon mortgage, is to offer a fully amortizing loan on existing rental properties where the rental income can more than sufficiently repay the mortgage and property expenses. Not only are you being repaid your principal invested, but there is less debt owed on the property over time, ultimately reducing your exposure to a loan default because so much equity is built up in the property.

Experience Level

Lending to a borrower with a track record of successful real estate investing is always preferable for private mortgage investors that are seeking a passive fixed income. While you could loan to a first time investor with perhaps a larger down payment, a first time borrower without real estate experience often is required to put additional cash into an investment real estate transaction to compensate for this increased risk.

Credit and Character

Life happens and often bad things happen to good people. Some real estate investors who have owned properties and personally signed for loans have experienced foreclosures or loan modifications on properties they owned over the past few years. This does not in and of itself rule out making a private mortgage loan, however, often times a large cash down payment is required and/or a reduction of the loan to value is required to reduce the loan default risk.

In an age of global financial markets being so interdependent, hard earned dollars are put into investments with the risk of loss often obscured. Why not invest in what everyone on earth needs to live; a place called “home”. When facilitated in a thorough and conservative manner, private mortgage loans are a great source of passive income with the ability to preserve your principal investment even in the event of a loan default.

1. Question: Who is my point of contact Answer: The principle of Metropolitan Financial

2. Question: Other than my work sheet, what is do you require? Answer: See below

a. Verification of borrower’s payments, preferably from a servicer.b. Copy of the notec. What are your expectations of what you want to receive? How much of a discount are you willing to accept?d. Forbearance Agreement;e. Mortgagee’s Title policy;f. BPO with interior pictures;g. Proof of homeowner’s insurance;h. What name you hold the note in?

3. Question: Who pays for the due diligence? Ie, credit reports, title checks etc Answer: As the buyer (broker), Metropolitan does.

4. Question: What is the turnaround time to give me answer? Answer: It depends on how complete the file is.

5. Question: What types of note collateral will you consider? Answer: Only notes secured by residential properties, commercial properties, land, business notes, etc.)

6. Question: What size notes do you prefer? Answer: Any size will be considered. Any quantity will be considered.

7. Question: When a quote is accepted what do you want me to do? Answer: Respond quickly and thoroughly to any questions Metropolitan may have.

8. Question: When a quote is accepted what do you want me to do?

9. Follow our instructions. Most likely we’ll ask you to deliver your collateral file to an escrow company and send up copies of the file as needed.

10. Question: Do you take care of all of the due diligence? Answer: Yes, with your cooperation.

Clearly investors have turned toward the buy, fix and rent model. That’s great if you are looking for a 6% to 8% yield and are prepared for the headaches of being a property owner and landlord. Our response is “why be a landlord when you can get a higher yield without the hassles of being a landlord by purchasing the mortgaged backed note?”

In 2012, Wall Street clearly recognized the opportunity to buy distressed single-family homes (SFH’s). The private equity firms had typically avoided this space but unattractive yields in other entities caused them to look at single-family homes as a better investment so they entered the market in a huge way.

Private equity firm, Blackstone, has purchased over 29,000 SFH’s in less than a year. They recently raised billions to purchase more. Carrington, Colony America, Silver Bay and others have a combined purchase of tens of thousands more SFH’s.

“It’s hard to find a private-equity firm on the planet that doesn’t have a strategy in this space,” Gary Beasley, chief executive officer at Waypoint Homes, said last week at the American Securitization Forum’s annual conference in Las Vegas.

But it doesn’t stop there. Wealthy Americans, looking for better and safer yields, are pooling funds into partnerships that purchase SFH’s. According to a recent article in Bloomberg: “The firm’s unit that caters to individuals and families with more than $5 million, put client money in a partnership that bought more than 5,000 single family homes to rent in Florida, Arizona, Nevada and California”, said David Lyon, a managing director and investment specialist at J.P. Morgan Private Bank.

We doubt that most of them are simply enamored by real estate. We doubt that they really want to be a landlord and have all of those responsibilities. In fact most investors would argue that being a landlord takes a fairly high tolerance level in dealing with tenants and tenant related issues even if you have a property manager. So why are they purchasing and renting? Is it the yield? In the same Bloomberg article, David Lyon said:
“Investors can expect returns of as much as 8 percent annually from rental income as well as part of the profits when the homes are sold”, he said.

Other fund managers, such as Sandeep Bordia, from Barclays, said: “Even as the housing market probably will do well across the nation, areas where property prices already are high such as San Diego, Los Angeles, Denver and San Francisco, will see lower rental yields, of 4 percent to 5 percent”

Is that kind of a yield really worth it? Are they making the kind of yields that they hoped?
Blackstone reported a 6% yield and although 85% of their renovated homes are leased, their department head said, “We have an awful lot of homes to continue renovating.” Bruce Rose, CEO of Carrington Homes, said, “We just don’t see the returns there that are adequate to incentive us to continue to invest.” American residential Properties and Silver Bay both reported loses in the first quarter of 2013.

So what has happened? Did they over pay for the properties? Did the under estimate the renovation costs? Did they not anticipate the time and cost of getting a qualified tenant? Are the costs of property management and property upkeep cutting into their margins? The short answer is yes. Yes on all accounts.

Is there a better investment that can provide better returns without these other issues? Can an individual investor do better? Yes! Invest in performing and re-performing mortgage backed notes.
When you invest in these notes, you:
•Do not buy the property
•Do not pay to renovate a property
•Do not have to get a tenant
•Do not have to hire a property manager
•Do not have to deal with any tenant issues (because you don’t have one)
•Do not pay to upkeep the property
•Do enjoy monthly cash flow
•Do enjoy double digit yields
•Do have a secured investment
•Do have an automated system where the debt servicer collects the payment and wires it into you account
•Do have a debt servicer who verifies property taxes and insurance payments are made
•Do have the ability to make this tax free (an allowable investment for an self-directed IRA or 401k and
other retirement accounts)
•Do have the ability to buy these at a discount

If you compare this to the landlord model, there really is no debate. Mortgage backed notes simply make a better investment. After all, you are simply acting as the bank.

To give you an example, this week we entered an agreement to purchase a performing note. The original note was created for $45,000 after the buyer put $20,000 down on the purchase of a $65,000 SFH. The note was created at 8.9% interest for 150 months. After 11 months, the note owner decided to sell the note. The note has an unpaid balance of $42,772. We have an agreement to pay $36,199 for the note giving us a 12.75% yield. We will receive $499.59 a month for 139 months. No land lording, no hassles; simply monthly auto-deposit cash flow backed by a $65,000 SFH. This puts us at a 56% investment to value ratio, meaning that the collateral is worth almost twice as much as our investment.

Another larger multi-family deal that we have under a purchase agreement this week will produce a 15% yield. This property sold for $490,000. The buyer put $125,000 down and created a $365,000 note with the seller. The note was created at 4% for 84 months. After receiving a few years of payments, the note owner decided to sell the remaining 56 months of payments for cash now. We will buy the note, with an unpaid balance of $253,109, for $191,714. So we will receive $4905.55 for 56 months for our $191,714 investment. Is it safe? The property is worth about $500,000! That means we are at a 39% investment to value ratio.

Knowing what you now know, why would you buy, fix and rent when you can just own the mortgage backed note and the monthly cash flow it represents?

Why would a seller allow a buyer to make payments over time for the purchase of property?

Wouldn’t the seller rather get paid now and require the buyer to obtain a bank loan?

Here are 5 reasons property owners offer seller financing:

1. Reduced Marketing Times

What is the first thing a real estate agent does when property is not moving and has been on the market for 60 to 90 days? They reduce the price and add the tagline “price reduced” to all advertising and signs. Rather than reduce the price, it might be beneficial for the seller to offer financing. Buyers provided with financing can certainly pay full price in exchange for the many benefits they receive with owner financing, including the money they save by not paying expensive loan fees, origination fees, and points.

2. Increased Inventory of Prospective Purchasers

By offering owner financing, the seller increases marketability with a wider group of available purchasers. Statistics show that almost 40 percent of the American population is unable to qualify for traditional bank financing. While not all of the “unqualified” group would be an acceptable risk for owner financing, it still widens the market of prospective buyers considerably. Anyone who has added the words “Owner Will Finance” or “Easy Terms” to a For Sale ad or Multiple Listing Service (MLS) listing knows the phone will ring off the hook with interested prospects.

3. Reduced Closing Times

Another advantage of offering owner financing is substantially lower closing times. A closing involving a third-party conventional lender can take six to eight weeks while closing a seller-financed transaction through a reputable title company can take as little as two to three weeks. This is due to the reduced paperwork and less restrictive due diligence process.

4. Investment Strategy for Hard to Finance Properties

There are many properties that encounter financing difficulties including mixed use property, land, mobile and land, non-conforming, low value, and others. Investors realize excellent returns by paying a reduced cash or wholesale price on a hard-to-finance property and then reselling at a higher retail price with easy financing terms.

5. Interest Income

Why let the banks earn all the interest? Sellers can keep the property-earning income even after they sell by offering owner financing. For example, a $100,000 mortgage at 9 percent with monthly payments of $804.62 will pay back $289,663.20 over 30 years. That additional $189,663.20 (over the $100,000 mortgage) is power of interest income!

Work with Owner Financing Specialists

If considering seller financing, be sure to consult with a qualified professional to properly document the transaction.

It also helps to speak with note investors to gain insight on appealing terms and structuring techniques. This assures top-dollar pricing should you ever want to convert the payments to cash by assigning your note, mortgage, deed of trust, or contract to an investor.

Would you rather have $97,000 to sell your $100,000 note or only $80,000? The difference in usually comes down to the big three. Here’s the three biggest mistakes note sellers make and how to avoid flushing money down the drain.

Mistake #1 – Failing to Check Credit

The payer’s credit report lets you know how timely they have paid bills in the past. This is a good indicator of how they will pay on a seller-financed note. It also has a huge impact on how much an investor is willing to offer, should the seller ever decide to sell the note payments. Sadly, many sellers never check credit when offering owner financing.

The seller financing solution?

Have the buyer fill our a simple one page application that grants permission to pull their credit upfront or ask the buyer to pull their own credit and provide the report. Whenever possible, avoid accepting owner financing from any buyer with a credit score below 650 (above 700 is ideal).

Mistake #2 – Charging a Low Interest Rate

Money today is worth more than money tomorrow. A simple look at escalating food and gas costs will show a dollar today won’t buy as much next year or the year after! This concept, known as the time value of money, plays a large role in investor note pricing.

All factors being equal, an investor will pay more for a higher interest rate note. We’ve seen sellers charge 5% or less on notes. Imagine the discount when an investor wants a 10% yield!

The seller financing solution?

Charge at least two to four percent above the standard bank loan rate for a similar loan transaction. Be sure to take into consideration the credit, property type, and down payment, which may justify further increases in the interest rate.

Mistake #3 – Low or No Down Payment

The down payment determines how much equity the buyer has in the transaction. The greater the equity, the less likely a buyer will default. There is a reason banks require mortgage insurance whenever a buyer puts down less than 20%!

In desperation, some sellers will even accept a zero down payment. Unfortunately, these buyers have even less at stake than a renter. A renter at least has a security deposit along with the first and last months rent!

The seller financing solution?

Require a down payment of at least 10% to 20% at closing.

So these are the BIG three when it comes to valuing a seller financed note. Sure other things come into play (including property type, seasoning, terms, etc) but these are the three that impact pricing the most.

While a seller might not be able to find a buyer that meets the ideal in each category, they can attempt to compensate for any deficiencies. For example, a lower credit score might result in a higher down payment and interest rate. A great credit score might result in a more favorable interest rate.

Just remember that when the buyer receives a break, it’s coming out of your pocket as the seller!

The amount a buyer can afford to spend on a house depends on their income, overall debt, cash they can put down, credit rating, and the mortgage terms.

There are three different calculations that are traditionally used by mortgage companies to determine how much house a buyer can afford. These are known as the Income Rule, the Debt Rule, and the Cash Rule. While owner financing does not require the strict use of these rules, it makes sense to utilize the standard as a guideline. (Better safe than really sorry, right?)

1. Income Rule

If you ask a real estate agent or lender for an estimate of how much house a buyer can afford, they’ll typically use a version of the Income rule. The Income Rule says that the monthly housing expense — which is the sum of the mortgage payment, property taxes, and homeowner insurance premium — cannot exceed a percentage of income.

This is often referred to as the front-end ratio and ranges from 27 percent to 30 percent for most lenders.

If the maximum percentage is 28 percent, for example, and the monthly income is $4,000, the monthly housing expense can’t exceed $1,120 (4,000 x .28 = 1,120). If taxes and insurance on the home are $200 per month, the maximum monthly mortgage payment is $920. At 7 percent interest for a 30-year loan, that payment will support a loan of $138,282. Assuming a 5 percent down payment, the maximum price of the home this buyer can afford would then be $145,561.

2. Debt Rule

The Debt Rule says that the total debt expense – which is the sum of the total mortgage payment plus monthly payments on existing debt like cars, credit cards, etc. – cannot exceed a percentage of income.

This is often referred to as the back-end ratio and ranges from 36 percent to 43 percent.

If this maximum is 36 percent, for example, and the monthly income is $4,000, the monthly payment can’t exceed $1,440 ($4,000 x .36 = 1,440). If taxes and insurance are $200 a month, and existing debt service is $240, the maximum mortgage payment the buyer can afford is $1,000. At 7 percent interest and a 30-year loan, this payment will support a loan of $150,308. Assuming a 5 percent down payment, the maximum price of the home would then be $158,218. (You’ll notice that’s significantly higher than what we calculated using the Income rule.)

3. Cash Rule

The Cash Rule says that the buyer must have cash sufficient to meet the down payment requirement plus other settlement costs.

If the buyer has $12,000 and the sum of the down payment requirement and other settlement costs are 10 percent of the sale price, then the maximum sale price using the cash rule is $120,000 (12,000 divided by .10 = 120,000).

Since this is the lowest of the three maximums in this example, it would be the affordability estimate that is safest to use for this scenario.

Putting It All Together for Seller Financing

How much house a buyer can afford is easy to overestimate if you ignore one of the three rules. Don’t make the same mistake as many of the mortgage lenders that ignored these standards in past years.

Granting loans to buyers that could not afford the payment played a large role in the current sub prime toxic mortgage mess that is currently in the headlines. There is no federal bailout program for sellers accepting owner financing.

Play it safe and be sure the buyer can afford the house payment before accepting payments over time.